How to make your next investment Ponzi-proof

February 2013 | PROFESSIONAL INSIGHT | BANKING & FINANCE

Financier Worldwide Magazine

February 2013 Issue

Investors need to learn how to Ponzi-proof their money. Bernie Madoff is not the last of the scam artists. Since Madoff’s arrest in 2008 for orchestrating one of the largest, most egregious Ponzi schemes ever, we have seen many other instances where investors have been fleeced through obnoxious acts of securities fraud both in the United States and overseas. The commonalities among these scams illuminate what investors need to do to protect their investments.

In 2012, Claudio Osorio was charged with defrauding investors of over $40m and using investor money to surround himself with personal luxuries: homes in Miami and Colorado, loan on Maserati and country clubs. Osorio was also a major player in philanthropy and relied on his falsified reputation as a good guy to woo high net worth investors, such as NBA athletes. Osorio also cleverly had Jeb Bush as a board member of his company, InnoVida, which ultimately filed for bankruptcy as did Osorio himself when investors came looking to recoup their losses.

Jacqui Bradley was sentenced to over seven years in prison for running a Ponzi scheme in New Zealand that stole over $15m from investors. She and her husband (who died before he was sentenced) also used money from investors to support an outrageous lifestyle of expensive vehicles and clothes, first class trips and a $4m house.

The concept of taking money from unaware and trustworthy investors to finance a dream life filled with opulent personal items is a classic move for Ponzi-schemers. Madoff did it, so did R. Allen Stanford, Danny Pang and numerous other fraudsters before them. Investors need to be sceptical when they see money managers living so large. Scam artists know that perception is half the game: if clients perceive them as high-flying, influential or wealthy, then clients will presume that lifestyle has been rightfully earned. As we see, this is not necessarily the case.

Other frauds within the last few months have confirmed another need for investors to employ: background checks. Before Osorio was charged in 2012 he ran a company called CHS Electronics that had filed for bankruptcy protection in 2003 as a result of accounting scandals. Also, Osorio had been targeted in a criminal investigation in Switzerland in 2011. A little research into Osorio’s background would have revealed this history of dishonest business practices and investors would have known to avoid becoming the next of Osorio’s victims.

In 2012, Philip Horn, a financial adviser with Wells Fargo, pleaded guilty to defrauding clients. Horn had an impressive resume: Lehman Brothers, Salomon Smith Barney, Citigroup, Wells Fargo. He was registered with FINRA. A look at Horn’s FINRA registration determined there were 10 customer disputes between 2010 and 2012 – most of which involved customers claiming they were unaware of activities in their account and had not authorised trades in their accounts. A similar complaint was filed against him in 2001 while Horn was with Salomon. Potential clients of Horn’s would have been alerted to his pattern of questionable behaviour with even a simple review of Horn’s profile as a registered broker with FINRA. In addition, Horn had filed for personal bankruptcy protection in 1995, a sure sign that he was in financial distress earlier in his career.

Another interesting aspect of Horn is how he nabbed his clients (victims): he used his membership at a country club in California. It was this connection and reputation that fooled other investors into believing Horn was a solid guy. Horn, like Madoff, also avoided meetings in his office and only nonchalantly discussed business while on the golf course.

Horn, like others before him, used reputation as his accomplice. The victims of these frauds assumed someone else had vetted the guy and gave a stamp of approval. Every investor must take on the responsibility of doing his or her own due diligence; the evaluation process cannot be left to someone else.

Conducting exhaustive background checks before investing is no longer optional – it is mandatory. These checks should not just be a review of criminal records; neither Bernie Madoff nor R. Allen Stanford had prior criminal records. We know from scandals gone by that gathering background information can yield cautionary advice. Identifying an individual’s regulatory history (Stanford, Horn, Madoff); patterns of lawsuits by investors or former employers (Stanford, Osorio); controversial media attention (Madoff; Osorio); and, determining whether a person is living beyond his or her means (Stanford, Madoff, Osorio, Horn, Bradley) are just some of the crucial factors when assessing the character of the individual in charge of your investments. Also, contacting current and former business associates is an underutilised method of finding information that is not necessarily in the public domain.

Recognising the warning signs of a potential fraud is a veritable way for investors to Ponzi-proof their investments. Identifying patterns of questionable business practices will enlighten future investors and allow them to make intelligent decisions without becoming victims of the next scheme.

Joelle Scott is Director of Business Intelligence at Corporate Resolutions Inc. He can be contacted on +1 (212) 691 3800 or by email: jscott@corporateresolutions.com